IO loan deductions (another newbe question)

[wagnman]

Gday all.

If you have an IP financed on a IO loan you are only paying the intrest on the loan each month (or week or when ever you are set up to pay it).

With an IP the interest you pay on the money you borrowed to buy the property is tax deductable right?

So.......

Does this mean that (as long as you pay enough tax on your salary to cover it) every cent you pay off on the IO loan you get back at tax time?

Monthly IO loan payment + Monthly rates, body corp, management fees and maintinence costs - rental income = monthly cost of ownership (-ve geared) with the monthly cost of ownership being 100% deductable so long as you pay enough income tax on your salary to be able to claim these expenses back.

Am I right?


Also when you have reached a point where you own enough -ve geared property so that you are claiming back all of the income tax you pay you need to really try hard to find +ve geared properties because you wont be able to claim any more losses back.

Is that right too?


Cheers

 

[alexlee]

Wagnman: very fundamental point you seem to be confused on. –ve gearing refers to TAX losses. These are deducted against your taxable income, NOT your tax paid. When we say you get tax benefits from interest paid, for example, we are saying you get PART of it back, so it just costs you less.

You need to be clear on the difference between DEDUCTIONS (that reduces your TAXABLE INCOME) and tax credits (that reduces your TAX PAYABLE: examples include franking credits from shares. In general property investing does not create tax credits).

If you have an IP financed on a IO loan you are only paying the intrest on the loan each month (or week or when ever you are set up to pay it).

With an IP the interest you pay on the money you borrowed to buy the property is tax deductable right?

Yes.

Does this mean that (as long as you pay enough tax on your salary to cover it) every cent you pay off on the IO loan you get back at tax time?

Wrong. There is no tax benefit to paying back the principle of a loan. So say your interest bill is $5,000 a year and in addition you pay another $2,000 into the loan. There is no tax benefit to the $2,000. The $5,000 is deductible. The cash effect is 5,000 x your marginal tax rate. Say it’s 30%, that means the $5,000 interest only ‘cost’ you $3,500 because you get $1,500 back in tax refunds.

Monthly IO loan payment + Monthly rates, body corp, management fees and maintinence costs - rental income = monthly cost of ownership (-ve geared) with the monthly cost of ownership being 100% deductable so long as you pay enough income tax on your salary to be able to claim these expenses back.

No. You claim them back at the INCOME level, not the tax payable level. So say you have $50k salary, you pay $15k tax and you have net $10,000 in tax deductions. You don’t deduct the $10k against the $15k tax paid (you wish). You deduct it against your $50k salary, and your tax payable is reduced.

Also when you have reached a point where you own enough -ve geared property so that you are claiming back all of the income tax you pay you need to really try hard to find +ve geared properties because you wont be able to claim any more losses back.

Again, you deduct expenses against your INCOME not tax paid.

If you make $50k salary, and your property expenses are $50k, then your income is zero. If your property expenses are 60k, your income is still zero. The $10k losses get carried forward to a future year when you do have enough income.

In practice, it’s unlikely you’ll reach that point, because the debts would have killed you way before you reached zero income.
Alex

 

[wagnman]

thanks heaps for the replies alexlee.

i had a good conversation today with someone that explained it to me pretty well too.

the costs of the property just lower the amount of gross salary that I would pay income tax on.

that point is locked and loaded.

Cheers V much.

 

[alexlee]

Now, do you understand the difference between cash tax expenses such as interest, insurance, management fees, etc and non cash tax expenses such as depreciation and how they impact your cashflow?
Alex

 

[VCDenton]

nice replies Alex

Would be great if you can elaborate on your last post.

 

[alexlee]

Would be great if you can elaborate on your last post.

The bit about cash and non cash deductions? Basically, cash expenses (pm fees, interest, insurance, etc) are deductible against other income. So after tax, a $200 insurance premium, assuming you're on a marginal tax rate of 30%, means it costs you $140 AFTER tax.

Depreciation is different. You get the deduction but didn't have to pay out cash. So, if you claim $1,000 depreciation, the after tax cashflow is +300.

All deductions are not equal.

I tend to think of everything in terms of after tax cashflow. Makes it much easier to know your true position. e.g. two properties each have $20,000 net tax loss. That doesn't tell you the whole story. You need to know how much depreciation this includes.

e.g. property one has rent of $10k, interest and cash expenses of $10k and depreciation of $20k. This is actually cashflow positive.

Property two has rent of $10k, interest and cash expenses of 30k and no depreciation. This is costing you $14,000 a year.

The numbers are pulled out of thin air, of course.
Alex

 

[wagnman]

Now, do you understand the difference between cash tax expenses such as interest, insurance, management fees, etc and non cash tax expenses such as depreciation and how they impact your cashflow?
Alex

Im slowly getting the idea.

So things you have to pay out cash for that are expenses that you incur in the course of your investing (such as the interest, insurance, management fees you mantion above and the -ve difference between what you get in rent and whet you pay out in morgage payments). These things you are deductable at the same rate as your tax rate (ie 30% in your example) so if you spend $100 on cash tax expenses you can claim $30 (or what ever % tax brackeet you are on) back come tax time.

The non - cash tax deductions are also considered as a kind of income or cash flow in that you dont have to spend money to get the deduction so the theoretical $1000 depreciation vields $300 cash flow based on your %30 tax rate.

Im still not fully grasping these concepts but Im definately getting closer.

Thanks for the replies guys.

Non cash tax expenses such as depreciation are worked out differently in that you deduct them from your gross salary before tax so that over all you are taxed on a lower gross figure which may either drop you into a lower tax bracket or reduce the gross figure you are taxed on even if the amount is not enough to drop you down a full tax bracket.

 

[alexlee]

So things you have to pay out cash for that are expenses that you incur in the course of your investing (such as the interest, insurance, management fees you mantion above and the -ve difference between what you get in rent and whet you pay out in morgage payments).

You're double counting interest. Interest IS your mortgage payment.

These things you are deductable at the same rate as your tax rate (ie 30% in your example) so if you spend $100 on cash tax expenses you can claim $30 (or what ever % tax brackeet you are on) back come tax time.

They are deductible against your income. If, at that level, your marginal tax rate is 30%, you 'get back' 30% of it. Not necessarily at tax time, because you can do an income tax variation form.

The non - cash tax deductions are also considered as a kind of income or cash flow in that you dont have to spend money to get the deduction so the theoretical $1000 depreciation vields $300 cash flow based on your %30 tax rate.

Non-cash tax deductions are ALSO deducted from your income in exactly the same way as, say, interest. The difference is what you had to do to get that deduction. With insurance, say, you pay out $1,000, and the tax office lets you deduct it and gives you back $300. So it costs you $700.

With depreciation, you pay out nothing (though you will have to pay higher CGT in the future because it reduces your cost base), and get $300 back as per above. So it's $300 positive for you.

Non cash tax expenses such as depreciation are worked out differently in that you deduct them from your gross salary before tax so that over all you are taxed on a lower gross figure which may either drop you into a lower tax bracket or reduce the gross figure you are taxed on even if the amount is not enough to drop you down a full tax bracket.

Wrong. Both cash and non-cash tax expenses are deducted from your income (including salary, interest, dividends, etc) to arrive at your NET taxable income. Our tax is progressive, remember.

I don't really understand your last paragraph, but I think you have the basic idea. If your cashflow is so tight that moving down into another bracket will kill you, don't buy.

A VERY simple calculation:

Net taxable income = salary + rent - cash expenses - depreciation

Net cashflow = (salary + rent - cash expenses) x (1 - tax rate) + (depreciation x tax rate).

I haven't allowed for when your marginal income changes tax brackets.
Alex

 

[wagnman]

Im not worried about tax brackets because I own a company and pay my wife and I a salary out of it. At the moment we are splitting the salary evenly between us which makes it so our taxable income is minimised but if the need was there for me to change the split I could easily (say if we had a -ve geared property and needed one of us to earn a higher income to pay more income tax to be able to claim the deductions back).

The "problem" we have at the moment is we bring in over $150K per year and have minimum repayments of only $520 per week on our PPOR mortgage and with the company covering all our vehical expenses we have heaps of spare cash that we want to invest with.

We want to maximise the number of properties we can purchase over the years by buying smart (IE not too -ve geared or if we do buy -ve geared be sure we are going to get good capital growth to off set the -ve gearing).

To buy smart we need to under stand all these details of the way the tax works and how the different deductions work so that when my wife comes to me and says she has found a great property I can analyse it and see how the numbers work out to see if it would be a bood thing for us to buy at the time.

Numbers and maths have always been a weak point for me (I can sell stuff and build my business very well but I cant do long multiplication LOL!) but I am very interested in this so I will learn it.

I like your simple rules.

Thats what Im after.

Simple formulas to use when assessing a property when I am looking at it on RE.com.

One I came accross on this forum the other day that I like too is.

"deduct 20% of the rent for holding expenses, deduct what rent there is left from the interest charge for how much you would have to borrow to buy the property = cash flow +ve or -ve"